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Monday, September 03, 2012

QE huh ?

Brad DeLong excerpts something by David Glasner

Consider how Bernanke explains the way that the composition of the Fed’s balance sheet can affect economic activity. 
"In using the Federal Reserve’s balance sheet as a tool for achieving its mandated objectives of maximum employment and price stability, the FOMC has focused on the acquisition of longer-term securities–specifically, Treasury and agency securities…. Imperfect substitutability of assets implies that changes in the supplies of various assets available to private investors may affect the prices and yields of those assets….
Declining yields and rising asset prices ease overall financial conditions and stimulate economic activity through channels similar to those for conventional monetary policy. "
Bernanke seems to think that changing the amount of MBSs available to the public can alter their prices and change the shape of the yield curve. That is absurd. The long-term assets whose supply the Fed is controlling are but a tiny sliver of the overall stock of assets whose prices adjust to maintain overall capital market equilibrium. Affecting the market for a particular group of assets in which it is trading actively cannot force all the other asset markets to adjust accordingly unless the Fed is able to affect either expectations of future real rates or future inflation rates. If the Fed has succeeded in driving down the yields on long term assets, it is because the Fed has driven down expectations of future inflation or has caused expectations of future real rates to fall….

I totally lost it in comments.

Department of Huh ?  Update post huh ?  I think I understand Glasner's gross errors.  There are two, but the principal is a misreading of a simple phrase used by Bernanke.  It seems that when Bernanke wrote "the prices and yields of those assets" Glasner read "change the shape of the yield curve".  I object to his use of the word "curve" which must describe a one dimensional manifold and, in this case, safe yields as a function of maturity.  The red flag to me is that Glasner chooses to discuss the purchase of MBS.  He must understand that the MBS yield does not appear on the yield curve (as the phrase is used and for any use of the phrase consistent with the meaning of the word "yield").  Basically he seems to be assuming that anything which is true of purchases of 7 year treasury notes must be true of purchases of MBS.

Also I think the claim "a tiny sliver of the overall stock of assets" is simply false.  2 Trillion is not tiny compared to anything.  In particular it is not trivial compared to $ 13.7 trillion or the US Federal debt.

Glasner assumes that the point of buying MBS is to affect the price of other assets.  But the US has a special problem with home building (and public spending) and not with investment in general.  The claim that the price of MBS has no effect on mortgaging would be crazy, but Glasner assumes it.

I flag also "the only".  This is a very strong claim.  Finally I note that if Glasner were right then Bernanke might as well take a vacation.  According to his logic, the Fed can affect the economy only through short term safe rates and expected future short term safe rates.  Again by his logic, these are summed in long term rates.  In particular if Bernanke can't credibly signal what policy will be after his current term ends, then the room for further easing is bounded by the 5 year rate which is currently 0.69%.  According to Glasner Bernanke is almost pedal to the metal on QE just as he is pedal to the metal on conventional monetary policy.

I note that his confident assertions about the logic of QE are diametrically opposite to Joe Gagnon's.  Gagnon (and his humble undersigned follower) advocate the purchase of MBS and, in particular, a significant fraction of MBS outstanding.

OK finally Bernanke is partly responsible for Glasner's bizarre essay.  It makes sense as a critique of the logic of QE II.  Bernanke refuses to distinguish QE I from QE II or Twist.  Bernanke's argument is that some QE I worked so the sum of the effects of I II and twist was significant, so we should do something like QE II again.  The equivocation of QE I and QE II seems unavoidable so long as they are distinguished only by numbers.

Ah numbers.  It seems to me that the discussion (especially but not only Glasner's contribution) is contaminated by indifference to numbers such as the difference between hundreds of billions and billions, the difference between 5 year and 100 years, the difference between 0.67% and 2.3% (this is the range of 5 year rates over a period when the discussion of QE changed not at all).

And finally tools of our tools.  Many seem eager to use the concepts developed to discuss monetary policy in the past to discuss current policy.  So expected future inflation is a key concept and a $ 1 Trillion is tiny.

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